With Russia's economy in the vice of sanctions and tumbling oil prices, talk has turned to potential crises. If it is to come, one of the most likely candidates to cause it will be a wholesale collapse of Russian regional finances. What the Kremlin chooses to do is made all the tougher thanks to the looming parliamentary elections this year and key presidential elections in 2018.

Thanks to its reserves and hard currency funds, the modest capital account surplus and low debt levels, Russia's top level macroeconomic fundamentals look pretty healthy. The state has a huge pile of cash to draw on and debt levels are in the early teens. It can absorb shocks and weather storms without too much difficulty – as it has had to.

Not true at the regional level, where local bosses don't have the luxury of cash piles or billions of dollars earned from oil export duties. They have to eat what they kill in terms of VAT and corporate profit tax revenues, turning to the central government for top-ups when this is insufficient.

"In Standard & Poor's Ratings Services' opinion, measures proposed by the Russian federal government to reduce fiscal pressure on its local and regional governments (LRGs) will likely not prevent the rapid deterioration of the regions' financial performance," international ratings agency Standard & Poor's (S&P) said in a report laconically titled "The Russian Government's Relaxation Of Pressure On LRGs Won't Prevent Their Financial Performance Materially Deteriorating", released in December.

Russia's regions have been under a lot of pressure to cut spending since the "May Decrees" were introduced in 2012, demanding that regions increase spending on wages and introduce a raft of changes to improve the population's life. The financial performance of Russia's regions has been mixed: while only 6 out of 89 regions were net contributors to the budget in the 1990s (mostly oil producing regions, plus Moscow and St Petersburg), that number has increased to about 25 now, with another 25 more or less breaking even and the remainder dependent on hand outs from the centre.

But since the global crisis broke in 2008, the number of profitable regions has been shrinking again as they struggle to generate enough taxes to meet the demands to increase social spending in particular, as part of the May Decrees' politically charged reforms are designed to counter the protest movement that reappeared in December 2010.

The regions will report operating deficits from 2018 and deficits after capital accounts will double to over 10% of total revenues between 2015 and 2018, says S&P.

"Deterioration is primarily because of weak revenues. We expect the local and regional governments (LRG) tax revenues will be undermined by stagnating GDP and shrinking, if any, corporate profits, whereas federal-to-regions grants will not likely increase, owing to pressure on the federal budget. With another year of very low spending growth, the capacity for further spending cuts is also reaching its limits," S&P said.

The government has already made all the easy cuts it could, forced on it by tanking oil prices and a slowing economy. The state ran a federal budget deficit for the first time since 2008 of about 3% in 2015 but has not curbed its massive spending programme on military modernisation nor the heavy spending on the social sphere which together account for about half of this year's budget spending plan. But with oil falling further to under $33 per barrel in the first week of January, even the reduced spending plan which has reduced the oil breakeven price for the budget from $115 to $70 is starting to look wildly optimistic.

Clearly if oil stays low the government will have to make more cuts: the question is what will it cut? The federal government is facing a difficult choice. "It might accept its inability to carry out the president's promise to increase public wages in regions and force regions to continue austerity measures; or it might demand LRGs accelerate spending, resulting in even more dramatic weakening of their balances. Both options carry significant political costs, especially in light of upcoming federal elections," says S&P.

If the regions are forced to carry the can of increased spending without more help from the centre their only option is to borrow from the domestic market. While Russia's sovereign debt is very low by international standards, this could increase the average regional debt to an average of 60% of consolidated revenues, according to S&P's calculations, which would, "no longer qualify as low in an international context".

"Due to reliance on short-term commercial debt and growing interest payments, we estimate LRGs' debt service will likely reach a material 15% of operating revenues in 2018, exposing regions to high refinancing risks. At the same time, the banking system's ability to expand lending to LRGs will likely be challenged by growing structural weaknesses in the system. We anticipate that LRGs will have to borrow more than RUB2.8 trillion (about $41.5bn as of December 7, 2015) from banks over the next three years," says S&P.

That is a lot of money. The federal reserve fund had slightly less than RUB4 trillion in it as of the end of 2015 and the Finance Ministry had earmarked RUB2.5 trillion to cover the spending shortfall expected in the federal budget for 2016, leaving a bit more than RUB1 trillion in the fund as a reserve. However, after oil fell to the low 30s in January, the government is now facing the prospect of exhausting not only the reserve fund, but also its twin National Welfare Fund, which also holds some RUB4.6 trillion as of the start of 2016, as the deficit could balloon out to 5% of GDP this year at those oil prices from the planned 3% if the average oil price stays at the assumed level of $50 per barrel.

The situation is already bad and likely to get worse this year, even if oil prices recover to the $50 the budget assumes. As of December 2015, S&P had already given two thirds of Russia's 83 regions a "negative outlook" credit rating for this year. Even Russia's six strongest regions (the cities of Moscow, Surgut, and Novosibirsk, as well as Leningrad Region, Yamal-Nenets Autonomous District, and the Khanty-Mansiysk Autonomous District all had negative outlooks. The only Russian region that received a positive ratings action in all of 2015 was the city of Ufa in Bashkortostan after it took action to improve its liquidity position.

Still, this will be a slow moving train wreck as the central government still has significant resources to patch up leaking pipes. Part of the 2016 budget is a special "industrial support" facility worth RUB1 trillion that is under the direct control of President Vladimir Putin and can be spent on anything he likes, which can be used to prop up the wobbliest regions and most still have significant borrowing capacity left. S&P predict the burden of growing debt will not become unbearable until 2018 at the earliest. That gives the government a two-year window of opportunity to make deep structural changes to head off the problems, but there is still no plan on the table to do this.

"In the medium term, total LRG revenues will grow by a modest 4-5% because of only marginal real GDP growth in Russia of about 1% annually, lower world oil prices, and federal transfers whose amount remains constant in nominal terms (and hence is decreasing in real terms). At the same time, we think that both the regions and the federal government will probably have to increase spending growth to service underfinancing accumulated in 2014-2015 and the upcoming federal elections," says S&P.

Much will depend on how aggressively the Kremlin orders regions to increase spending in the run-up to elections to ensure political victories. There are parliamentary elections scheduled for 2016 and presidential elections in 2018. Putin has already made generous promises and if regions are forced to keep them this will impact heavily on their balance sheets.

"However, even with these new guidelines, meeting the president's wage growth targets is becoming increasingly difficult, if it's possible at all. This is primarily because of LRGs' stagnating tax revenues and inadequate federal grants," S&P says. "Wages in many social sectors are still well below 2018 target levels set by the federal government. And meeting them in full implies unsustainable spending growth in 2017-2018. For this reason we believe that the federal government will face a difficult choice. It might have to publicly accept that Putin's decrees are unlikely to be carried in full or on time (i.e., by 2018) and force LRGs to continue with cost cutting. Or, it might force regions to accelerate spending growth significantly, resulting in the material expansion of LRG deficits."

Putin's popularity is currently skyhigh, but the question he will have to answer in 2016 is if he can really cash in this popularity on paper for voters support at the polls if their personal situation deteriorates significantly in the next two years? If he chooses prudence then he will be taking a big political gamble, which he has shown himself willing to do in the past with the 2008 presidential elections. But if he choose to spend to meet his promises then he could destabilise the economy and face bankrupting the weakest regions.